The Valeant Litigation plaintiffs allege that Valeant failed to disclose that it had engaged in price gouging and had created a secret network of specialty pharmacies in order to avoid scrutiny. Plaintiffs further allege that once Valeant’s deceptive practices were disclosed to the public, Valeant’s share price fell dramatically. Counts III through VI of the plaintiffs’ complaint alleged violations of Section 12(a)(2) based on purportedly defective disclosures in the offering of senior notes to QIBs pursuant to Rule 144A (the “Note Offerings”). The offering memorandum for these Note Offerings stated that the notes would not be registered with the S.E.C. or offered to the general public.

Relying heavily on a string of cases from the U.S. District Court for the Southern District of New York and the Supreme Court’s decision in Gustafson v. Alloyd Co., the Valeant defendants argued that the plaintiffs’ section 12(a)(2) claims failed as a matter of law because Section 12(a)(2) does not apply to private placements of securities conducted pursuant to Rule 144A. They argued that Section 12(a)(2) imposes liability for defective disclosures “by means of a prospectus,” and “cannot attach unless there is an obligation to distribute the prospectus in the first place.” Defendants reasoned that the term “prospectus” relates only to public offerings and that Section 12(a)(2) thus cannot impose liability for misstatements in marketing materials for non-public offerings that do not require a prospectus. They concluded that offerings made pursuant to Rule 144A—such as the Note Offerings—are by definition not made to the public and thus exempt from the registration and prospectus requirements of the Securities Act.

Plaintiffs responded by asserting that Section 12(a)(2) requires the court to engage in a fact-specific inquiry to determine whether offerings made pursuant to Rule 144A are public or private. They claimed they had pleaded enough facts to show the Note Offerings were public because the alleged that Valeant issued billions of dollars of debt in what the plaintiffs alleged were “some of the largest and most widely dispersed corporate debt offering of all time.” Relying in part on the In re Enron Corp. Sec., Derivative & “ERISA” Litig. plaintiffs argued that Rule 144A was not intended to disrupt the fact specific inquiry required to determine whether an offering is public.

Notably, the Securities Industry and Financial Markets Association (“SIFMA”) submitted a brief as amicus curiae in support of the Valeant defendants argument that Rule 144A offerings are not subject to Section 12(a)(2). In their brief, SIFMA argued that if courts should not determine potential Section 12(a)(2) liability on a case-by-case factual determinations. According to SIFMA, such a post hoc factual analysis would “undermine the objectives that Rule 144A was intended to achieve, raise the cost of capital for companies and U.S. investors, and undermine the critical certainty and predictability that the federal securities laws are intended to provide.” If a Rule 144A could be deemed “public” after the fact, SIFMA argued, then prospective issuers would either have to restructure their transactions to price in the costs of liability and exposure associated with registered public offerings or forego raising capital in the United States.

The District Court ultimately rejected plaintiffs’ argument, granting defendants’ Motion to Dismiss Counts III through VI and finding that “exemption from registration and non-public status are necessary consequences of compliance with the conditions of Rule 144A.” The Court further noted that “[a] majority of courts to rule on this issue, including the Southern District of New York, have adopted this interpretation of Rule 144A and its effect on Section 12(a)(2).”

The District Court’s decision, along with other recent decisions in the Southern District of New York, suggests that investors seeking to recover under Section 12(a)(2) for purchases made at an offering made pursuant to Rule 144A will face an uphill battle. These courts declined to undertake a factual analysis to determine whether Rule 144A offerings were public or private, finding instead that they are public as a matter of law. These ruling could insulates all Rule 144A offerings from Section 12(a)(2) liability regardless of the facts surrounding any particular offering.

For plaintiffs, this is an unfortunate result. Section 12(a)(2) does not require proof of scienter and does not carry the heightened scienter pleading requirements needed to successfully plead a Section 10(b) claim. Basically, under Section 12(a)(2), if the plaintiffs can plead that there is privity and they can allege a material misstatement or omission, the burden falls on the defendants.

Joel Rothman is an Associate in the firm’s Boston office. He advises institutional investors with respect to securities class actions, with a focus on evaluating opt-out opportunities and foreign actions. He regularly advises clients at all stages of civil litigation, from pre-litigation counseling and investigation through discovery, trial, and the appeals process.

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